What to Do With Your Old 401(k)

By Karin Price Mueller

Published June 24, 2011

SecondAct

If you've switched jobs, you have a decision to make about your 401(k) account. You basically have four choices: Leave your account as is with your former employer's plan, roll the money into to your new company's plan, roll it to an IRA or withdraw the funds completely.

Making the wrong decision -- or taking no action at all -- could be costly for your family's financial security.

Here are the options you should think about as you weigh the future of your retirement savings.

1. Leave the Money Where It Is

A recent Fidelity survey found about two-thirds of retirement plan participants left their retirement savings with their former employer's plan after they left their jobs.

That's often the wrong move.

You may have felt satisfied with your employer plan while you were working there, but it's more likely that you didn't give the company plan much thought. As an employee, it was your only option if you wanted to invest in a pre-tax retirement savings plan.

Most 401(k) plans have a limited number of investment options. And if you're like most 401(k) investors, you're probably not sure what fees and expenses are levied against your account.

"Certain 401(k) plans are annuity products that can have an extra 2 percent-plus in fees annually, which can have a huge impact on performance," says Jerry Lynch, a New Jersey-based certified financial planner.

The Fidelity survey also found that 37% of those who planned to move their old 401(k)s did so for lower fees, and 26% said they wanted more investment options.

There are two sets of rules associated with retirement accounts, Lynch says, so keeping your account with a former employer can subject you to limitations beyond those set by the IRS. "This can mean that the plan will not allow for complex beneficiaries, such as several of your children, or other things that can affect how the assets come out to heirs," he says.

If you decide to leave the money with your old company, make sure to check on performance twice a year, rebalancing the account so you maintain the correct percentages of stocks and bonds. (Here's how to do a 401(k) checkup.)

2. Roll It Into Your New Plan

If you've started a new job, your employer may allow you to move your old 401(k) into your new one.

"You do have the benefit of consolidating the accounts," says Linda Homsey, a Winchester, Mass.-based certified financial planner. "This may make it more convenient for you to keep track of your investments."

But that's not enough of a reason to roll the funds into your new plan, she says. Your decision should be based on the new investment options and fees.

If you felt your old employer's plan had limited investment options, your new employer's plan may not be much better -- or could be worse. The same goes for the fees charged on the account.

Before you move your money, carefully investigate the investment options in the new plan. Check out the plan's mutual fund options at Morningstar.com to see how the fund performs against its peers. Also check the expenses compared to similar funds. Use Morningstar as a tool to help you understand the fund's style, such as if it invests in large company stocks, foreign investments or bonds, income, and look at how the funds will fit into your overall asset allocation.

You also can get a report card for the new plan at Brightscope.com, a 401(k) rating service.
If the new plan and its investment options aren't what you want, don't move your old plan into the new one. You should still enroll in the new plan to take advantage of pre-tax savings and employer-matching funds, even if you're not thrilled with the choices.

One last note: If you think you'll someday want to borrow against the 401(k) account, moving your old plan into the new one may be smart. You can't borrow against an IRA.

3. Roll It Into an IRA

Moving your account into an Individual Retirement Account, or IRA, is usually the best and most flexible option, financial advisors say.

By moving the money into an IRA, you're opening yourself up to the entire universe of investments. You can choose any investment company you'd like to manage your account. Generally, you'll have the most options if you choose a so-called "fund supermarket," the kind of investment company that offers mutual funds from many different fund families, such as Schwab, Vanguard or Fidelity.

"I am a fan of having access to multiple investment options and families," Lynch says of fund supermarkets.

There is one caveat if you still hold company stock in your old 401(k) plan. Homsey says those shares qualify for special tax treatment, so you may not want to roll the stock if it has significantly appreciated. Instead, consider withdrawing the stock from the plan and rolling the balance of the account into an IRA or qualified plan.

"This is because the appreciation in the stock is subject to a special rule where it is not taxed until the stock is sold and the net unrealized appreciation is treated as long-term gains, which may be more advantageous than withdrawing it from an IRA where it would be taxed at ordinary income tax rates at the time of withdrawal," Homsey says.

If you do make the move to an IRA, be sure to request a custodian-to-custodian transfer, meaning you never take possession of the money. If you do take the money and you fail to move it into the IRA within a certain time frame, the rollover could be treated like a withdrawal and you'd owe a 10 percent penalty plus taxes on the money.

4. Withdraw the Funds

Your final option is to withdraw the money from your old 401(k), but that's something you should avoid at all costs. If you're younger than 59 1/2, you'll face a 10% penalty and taxes, and you'll be left without a nest egg for retirement.

During the recession, many people liquidated their employer retirement accounts because they needed the money to replace income after a job loss or to stop a foreclosure on a home. If you do need the funds, make sure you do it right. (My previous column on emergency 401(k) withdrawals is here.)

If you're thinking about using retirement funds to pay bills, you should reconsider, Lynch says, because 401(k)s and IRAs are protected assets.

"Taking money from a protected asset and voluntary handing it over to a creditor is crazy, unless it really 'solves' and does not just postpone the problem," he says.

SecondAct contributor Karin Price Mueller is an award-winning personal finance and consumer writer with The Star-Ledger and other publications. She lives in New Jersey with her husband, three children and two guinea pigs. Whatever they don't eat goes into her retirement savings accounts.